Short Straddle Direction: Sideways

Strategy Description

Short Straddle is one of the sideway strategies employed
in a low volatile stock. It usually involves selling At The Money puts
and calls options with the same strike price, expiration date and
underlying stock.

Limited to the Net Premium Collected from the At The Money puts and calls options sold.

Breakeven :

Upside Breakeven = Strike Price Plus Net Premium Collected

Downside Breakeven = Strike Price Less Net Premium Collected

Net Position:

This is a net credit trade as you are selling the puts and calls options of the same strike price and expiration date.

Advantages and Disadvantages

Advantages:

Collect premium from puts and calls options and benefit from double time decay and a contraction in volatility.

Disadvantages:

Potentially unlimited loss beyond the breakeven point in either
direction if the strike price, expiration date or underlying stock are
badly chosen.

Limited reward.

High risk strategy. Not recommended for inexperience traders.

Exiting the Trade

Let the options expire worthless and earn the full sum of premium collected

Simply offset the spread by buying back the puts and calls options that you sold in the first place.

Short Straddle Example

Assumption: XYZ is trading at $75.65 a share on Mar 20X1.
You are expecting share price of XYZ to fluctuate back and forth within a
range. In this case, you may consider to sell one Apr 20X1 $75 strike
call at $3.40 and sell one Apr 20X1 $75 strike put at $3.60 to profit
from the sideway movement of the stock. Note: commissions are NOT taken into account in the calculation.

This options strategy is directly the opposite of a Long Straddle
strategy and easier to understand. You just need to sell an equal number of puts
and calls options of the same strike price and expiration date. Then you
can make a profit when the stock fluctuates back and forth within a
range.

The maximum profit occurs when the underlying stock is trading at
the strike price at expiration date (where both puts and calls options
expire worthless). You get to keep the full amount of premium collected.
This option strategy can be executed at any strike price but is
typically established At The Money.

Try to ensure that the stock is trading range bound and identify
clear areas of strong support and resistance. Ideally you are selling
the options when the implied volatility is high and receive above
average premium. The stock is also anticipated to consolidate (become
less volatile) and trading sideway for the duration of your trade.

This is a net credit trade as you are receiving the premium for both the puts and calls options sold.

Remembering that the last month of an option’s life has the greatest amount of time value erosion occurring.

Therefore it is preferably to use this option trading strategy with
around 1 month left to expiration so as to give yourself less time to be
wrong.

This is typically a bet on the volatility
contraction. It is used to try to double the amount of premium collected
compare to only trading one side of the market. However, do notes that
you are exposed to potentially unlimited risk and you should NEVER
trade this strategy right before news or earning announcement! You may
be earning modest income on this strategy for a few months but one big
loss will wipe off your years of gains. It’s just not worth it.

You should pick the strike price and time frame of the Short Straddle
according to your risk/reward tolerance and forecast outlook of the
underlying stock. Selecting the option trading strategies with
appropriate risk-reward parameters is important to your long term
success in trading options.